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Sunday, 14 July 2013

Downside of a British E.U. Exit

By
HUGO DIXON | REUTERS

It is becoming increasingly likely that Britain will have a referendum on whether to stay in the European Union. It is not just that Prime Minister David Cameron
has promised to hold such a vote by 2017, assuming he is re-elected.
The drumbeats from the opposition Labour Party that it, too, would hold a
plebiscite are becoming louder. Opinion polls shows that Britons would
vote to quit.

Of the many industries that would be hurt by such a “Brexit,” the City
of London is the most prominent. The damage would range from moderate to
severe, depending on the extent of the amputation.

The City is not just the financial capital of Britain. It is also the
financial capital of Europe, and it vies with New York to be the world’s
financial capital. Britain accounts for 74 percent of foreign exchange
trading in the European Union and 40 percent of global trading in euros;
85 percent of E.U. hedge fund assets; 42 percent of Europe’s private equity
funds; and half of pension assets and international insurance premiums,
according to a recent report by CityUK, which represents the British
financial services industry.

What is more, 37 percent of the British financial services industry’s
trade surplus is with the rest of the Union; more than 40 percent of
foreign firms coming to Britain cite access to the Union’s single market
as a core reason for doing so; and about 40 percent of the tax take
from financial services is from international businesses operating in
Britain.

It is fantasy to suggest that all this business would vanish if Britain
quit the Union. But it is equally fantastic to suggest that the rules
that constrain how the City operates would go in a puff of smoke in such
a situation.

The extent of the damage would depend on the type of exit. The least
harmful would be a decision to quit the Union but stay in its common
market. That could be achieved by Britain’s becoming a member of the
European Economic Area, like Norway.

The snag is that E.E.A. members do not get to vote on the rules of the
single market. Britain would, therefore, be left in a position where the
rest of the Union. would have a free hand in determining how the City
was regulated. The Union might even deliberately damage Britain to shift
business to Frankfurt or Paris from London. In such a situation, many
firms based in Britain would relocate some activity across the Channel
to be closer to where decisions were made — dragging jobs and tax
revenue with them.

That is a worse position than the status quo. Although Britain cannot
currently veto E.U. financial services legislation, in practice it has
only once lost out: when Brussels decided this year to cap bankers’
bonuses.

But the damage would be far more severe if Britain quit the single
market as well as the Union and relied merely on its membership in the
World Trade Organization to give it access to foreign markets, as some
euro-skeptics advocate.

The W.T.O. is largely about protecting trading in goods, not services.
It would not guarantee firms based in Britain access to the common
market in financial services by what is known as the “passport.” That
entitles firms based anywhere in the European Union to provide services
anywhere else in the Union either remotely or by setting up branches, so
long as they are regulated by their home authority.

If Britain relied just on the W.T.O., firms wanting to do business in
the Union would have to relocate there by setting up subsidiaries. There
would be a loud sucking sound as both British and foreign firms
transferred jobs, wealth and tax revenue across the Channel. British
citizens would not necessarily even be able to follow those jobs abroad
because, post-exit, they wouldn’t have the right to work in the Union.

Meanwhile, the City’s competitiveness would be undermined if Britain no
longer allowed E.U. citizens to work in Britain. While it could let them
come, that seems an unlikely policy choice given that one of the main
reasons euro-skeptics give for quitting the Union is to stop immigration from it.

Britain is also unlikely to throw out its financial services regulation
if it quits the Union. It needs rules to keep the system from blowing
up. And it makes sense to coordinate those rules internationally to make
sure things don’t fall through the cracks as they did when Lehman
Brothers went bust in 2008. It is true that Britain would be free to
uncap bankers’ bonuses. But would that really be a populist priority
after an exit?

Some euro-skeptics say the City would be better able to act as the
world’s financial capital if it cut free from Europe. The opposite is
likely. The City enjoys economies of scale from being the financial
capital of Europe. Without that position, it would be less competitive,
and its ability to serve fast-growing markets in the rest of the world
would be compromised.

There are, of course, halfway houses between Norway’s position and
simply relying on the W.T.O. The damage to the British financial
services industry would then be somewhere in between that suffered in
those two situations. Far better to stay in the Union and push to
enhance London’s role as Europe’s and the world’s financial center. The
City should campaign for that vigorously.